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Macroeconomics: real vs nominal gross domestic product

Nominal GDP: 
  • A nominal GDP measures the value of a nation's output produced in a year, given the prices charged for that year. However, if prices increase while the output level stays constant in a given year, the nominal GDP will drastically increase, even though the level of production is equal to that of the previous year.

Estimating real GDP:
  • To determine the actual change in output from one year to the next, we must adjust the nominal value of a country's output in a year based on changes in the average price level during that year. 
  • Inflation is when the price level increases, whereas deflation is when the price level is decreasing.
  • To determine whether the nominal GDP overestimates or underestimates the output of a country, one must know whether the average price level has increased or decreased. In order to achieve this task can use a price index known as the GDP deflator.
  • The GDP deflator:
  • Real GDP is calculated by replacing the prices for that current year with those of the base year. Another popular index is the Consumer Price Index (CPI). The main difference with our previous formula, it is that this takes into account goods (and not services) both domestic and foreign (i.e imports).
  • CPI example:
  • To find either inflation or deflation using the GDP deflator, simply calculate the percentage change between the index numbers at time i and i-1 . If the number is positive, this indicates inflation. If the number is negative this indicates deflation.
Reference: Welker, Jason. AP Maroeconomics Crash Course. Research & Education Association (2014). p 70-74.

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